Velvel on National Affairs

This progressive blog sets forth the personal views of the Dean of the Massachusetts School of Law on national events. Occasionally, the responses to his views or other interesting articles are also posted.

Friday, September 23, 2011

Petition for Rehearing En Banc

UNITED STATES COURT OF APPEALSFOR THE SECOND CIRCUIT

PETITION FOR REHEARING EN BANC

PRELIMINARY STATEMENT

Petitioner, Lawrence R. Velvel, is a customer and victim of Bernard Madoff. Velvel was an appellant in the above-referenced appeal and seeks a rehearing of the Court’s August 16, 2011 decision, annexed hereto as Exhibit 1.

Velvel joins in the arguments made in the two petitions for rehearing submitted by others under date of September 2, 2011, but writes because extraordinarily important information concerning the intent of SIPC, the Trustee and the SEC was disclosed on September 16, 2011 in a 118 page report issued that day by the SEC’s Inspector General, David Kotz. That just-disclosed, crucial information regarding the intent of SIPC, the Trustee and the SEC was denied to Petitioner when he sought it via discovery request in the Bankruptcy Court in September, 2009. The discovery request was vigorously fought by the Trustee, Irving Picard, and by SIPC, and, in accordance with their position, was denied by Bankruptcy Judge Lifland. Petitioner contested this prior denial of crucial information in his opening brief and his reply brief on appeal in the Second Circuit, but the Panel’s decision of August 16th does not deal with the matter. Now, however, the relevant crucial information sought via discovery was disclosed on September 16th in the Inspector General’s report, and Petitioner urges that there should be an en banc rehearing to consider the information.

Though, as said, other petitions for en banc rehearing were filed under date of September 2, 2011, the allowable time for filing a petition is 45 days, not 14 days, under FRAP 40. That rule provides that, if an agency or officer of the United States is a party to a civil action, the time for filing for rehearing is 45 days after entry of judgment. (Judgment was entered here on August 16th.) Here the SEC, a government agency, is a party. Also, the Trustee, Irving Picard, is a Bankruptcy Trustee as well as a SIPC Trustee (and is clawing back monies as a Bankruptcy Trustee). The Supreme Court has ruled that “Trustees in Bankruptcy are public officers and officers of a court.” Callaghan v. Reconstruction Finance Corporation, 297 U.S. 464, 468 (1936). Because the SEC is a party, and the Trustee is a public officer, the time period for seeking rehearing to bring up the crucial information that was not disclosed publicly until September 16th is 45 days from August 16th, not 14 days.

PROCEEDINGS BELOW

As pointed out in the Petitions For Reconsideration filed under date of September 2, 2011, the appeal and the decision of August 16th, involved the question of how to define “net equity” under the Securities Investor Protection Act. From the beginning, SIPC and the Trustee have argued that net equity is to be defined by the cash-in/cash-out (“CICO” or “net investment”) method, while the appellants/petitioners have urged that the final statement method (“FSM”) must be used, as in every SIPC case in the nearly 40 year history of SIPA prior to Madoff. The panel held that SIPC and the Trustee could use the CICO method.

ARGUMENT

From the very beginning, there has been well-founded suspicion that, whatever legal rationalizations SIPC and/or the Trustee might assert to the courts as justification for using CICO, the real reason they used CICO rather than the FSM was fear that the SIPC fund did not have sufficient monies to make the legally required payments to victims if the FSM were used. For this reason, it was thought, SIPC and the Trustee (ultimately supported by the SEC) ignored Congress’ intent -- oft-stated on the floor of Congress by many of the leading Senators and Representatives of the 1970s -- that victims be compensated up to $500,000 and that they be compensated promptly. Rather than adhere to Congress’ intent, SIPC and the Trustee (ultimately supported by the SEC), decided not to use the FSM, which was used in all other SIPC cases, but instead to use CICO, which they knew would dramatically lessen both the number of permissible claims against the SIPC fund and the amount of money that would have to be paid from the fund.

Plainly put, from the earliest days the well-founded suspicion was that the Trustee and SIPC (ultimately joined by the SEC) ignored Congressional intent to aid investors and substituted for Congress’ intent their own intent to save money for the SIPC fund.

Because of this well-founded suspicion, in September 2009 Petitioner filed a discovery request seeking information on why SIPC and the Trustee had chosen to use CICO. SIPC and the Trustee vigorously, even stridently, opposed the discovery request, and it was denied by the Bankruptcy Judge.

On appeal, Petitioner argued in his opening and reply briefs that the denial of a discovery request that would have led to exposure of the real reason SIPC and the Trustee chose CICO -- as opposed to the legal rationalizations they provided to the courts -- was reversible error. The appellate panel did not deal with this issue.

There the matter stood until the SEC’s Inspector General, on September 16, 2011, released his Report on the conflict of interest question involving the former SEC General Counsel, David Becker. In the course of that official SEC Report, it was made clear that a desire to save the SIPC fund had been, from the very beginning, the driving force behind the decision to use CICO. The driving force was not the intent of Congress so often expressed on the floor of the Senate and House by leading Senators and Congressmen of the 1970s when SIPA was enacted and amended. It was not to protect investors, especially small ones, and build confidence in markets, as Congress intended SIPA to do. Rather, it was, plainly and simply, to save SIPC’s finances, with legal rationalizations then being offered to courts to attempt to justify this departure from the intent of Congress. Little wonder that the relevant Congressional intent never rates even a mention in briefs filed in various courts by the Trustee, SIPC and the SEC.

Thus it is that, in his Report, the General Counsel, after extensive investigations described at the beginning of his Report, says (pp. 49-50 (emphases added) Exhibit 2, infra.):

In addition, Becker discounted SIPC’s perspective that it was important to consider the effect of the net equity approach on the SIPC Fund. For example, in a May 28, 2009 e-mail, NYRO Assistant Regional Director referred to Harbeck’s general “desire to ‘protect the fund.’” Ex. 95. [Harbeck is the President of SIPC.] See also NYRO Assistant Regional Director Testimony Tr. at 70-72. The Chairman’s notes [SEC Chairman Schapiro’s notes] of her preparation for a June 25, 2009 SIPC meeting where the net equity issue was addressed referred to SIPC concerns about “drain[ing] the fund,” “necessitate[ing] SEC going to Congress,” and “dramatic fee increases for broker-dealers.” Ex. 92; Schapiro Testimony Tr. at 38-39. Chairman Schapiro testified that she thought that her notes indicated that the SEC was “very concerned that [SIPC] will say that if we go with a final account statement view of what [its] obligations are, that it will deplete the SIPC funds.”(Fn. 31) Schapiro Testimony Tr. at 39.

Fn. 31: The Chairman’s notes also indicated, “This is a SIPC survival issue.” Ex. 92; Schapiro Testimony Tr. at 43. She testified that she did not know who made this comment, but that “it may be that somebody said that’s how SIPC views this, as a survival issue . . . because the fund would be depleted, and it set a precedent that would be very hard for them to meet over time given the fact that these liquidations had become so huge.” Schapiro Testimony Tr. at 43.

There can therefore be no doubt that survival of the SIPC fund, and of SIPC itself, was the driving force behind the use of CICO. It was not the oft-stated intent of Congress to aid and protect investors and build confidence in markets that motivated SIPC and its handpicked Trustee to use CICO instead of the FSM, but an intent to save SIPC even though they knew, as the IG makes clear, that CICO would eliminate Congressionally-intended payments to thousands of victims.

All of this raises the following question, which was never addressed by the Bankruptcy Court or by the Circuit Panel in its decision of August 16th. Is it lawful for SIPC (established under a Congressional statute (SIPA), for its handpicked SIPC Trustee and Bankruptcy Trustee (Irving Picard), and for the SEC to defy the Congressional intent to aid investors and build confidence in markets, and to substitute for Congress’ intent the intent of SIPC and the Trustee to save SIPC -- to save it by using a definition of net equity which causes thousands of often small and now impecunious investors to obtain no compensation from the SIPC fund or the fund of customer property? Petitioner believes that, notwithstanding the many legal rationalizations they have offered to support this substitution of their own intent for the intent of Congress, SIPC, the Trustee, and the SEC cannot lawfully substitute their intent to save SIPC for Congress’ intent to protect and compensate investors, and that it is a violation of separation of powers for the Panel to have judicially approved and adopted a definition of net equity which overrides Congress.

CONCLUSION

For the foregoing reasons, Petitioner urges that the full Circuit should follow one of two courses in en banc reconsideration. One course would be (i) to accept the IG’s investigation and statements as dispositive of an unlawful intent to override Congress by not using the FSM, and to thereby deny payments to those whom Congress intended to be helped and compensated and (ii) to reverse the panel decision because the decision has allowed this unlawful action to occur. The second course would be to vacate the panel decision and remand to the Bankruptcy Court for further investigation, via discovery, of why SIPC and its Trustee chose CICO and pressed this upon the SEC vigorously (as the Inspector General’s report makes clear). The discovery, the Court should make plain, must include full production of relevant documents and depositions of the relevant actors in SIPC, the Trustee’s office, and the SEC.

About Dean Velvel

Name:Lawrence
Velvel

Location:Andover, Massachusetts,
United States

Dean Velvel, an honors graduate of
the University of Michigan Law School, has practiced law in the public and private sectors,
and been a law professor. He is the author of the quartet Thine Alabaster Cities
Gleam. The books in the quartet are entitled: Misfits In America, Trail of
Tears, The Hopes and Fears of Future Years: Loss and Creation, and The Hopes
and Fears of Future Years: Defeat and Victory.

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